The Importance of Being Ethical in Investments

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By Tapo Banerjee

I know Ethics is important for the CFA exams. But when I was preparing for my CFA exams, Ethics was one topic that always used to put me off to sleep. And I’m definitely not the only one.

To me it was really a lot of cramming without much to understand. I always prepared the section on Ethics a night or two before the exams. I guess the idea that someone could be motivated to be follow the path of righteousness if he/she isn’t inherently ethical eluded me. 

So why am I writing an article about the importance of Ethics? I have seen the light, and if you want to, I can help you see it too.

Why is Ethics important?

Recently I sought out an investment manager for financial advice. As a client.  And that’s when I realised ethics in investment is pretty important after all. While talking to the marketing guy the first thing that crossed my mind was:

“Will my investment be safe with this guy?”

It wasn’t “How much return he can generate for me?” or “Can he really outperform the market?” as he was claiming. I ultimately didn’t hire the manager, but the experience taught me that ethics is essential for the investment industry to function.

What happens if no one is ethical?

Just imagine a scenario in which a significant portion of investment managers – in search of short term profit – decides to take liberty with their fiduciary responsibilities. In the short term they will (presumably) make windfall gains. But in the longer term, investors will lose trust. They refrain from investing. General breakdown in the way transactions take place. Eventually the entire system comes to a grinding halt potentially causing material and irreversible damage to the real economy.

This doesn’t always mean that the perpetrators will be punished or even prosecuted. There are millions of financial and legal contracts being entered into every day. Even if 1% of those who entered into a contract renege on their obligations, it would overwhelm the courts and engulf many market participants in a deluge of legal expenses. But more importantly, it will put the entire system at risk.

But here is the most interesting part.

It won’t necessarily take rogue investment managers/market participants or people with ulterior motives for all of the above to happen. Even the impression of unethical behaviour or a minor misjudgement can trigger all of these effects. Markets are all about perceptions and expectation. Ethical behaviour is no exception. And this is where formal ethics education as delivered by the CFA program comes in. Actions that can be misconstrued as amoral are not always obvious. And also there may not always be enough time to evaluate such an action. Knowing the possible no–go zones beforehand often helps in such situations.

Why ethics, and not just follow the law?

Why do we need to study ethics? Why not just know and follow the law? Because there is difference between what is legal and what is ethical.

With the globalization of the world economy, investors are continuously looking out for new investment opportunities. Emerging markets can be popular, and can lack a robust legal and regulatory infrastructure necessary to protect the interest of the market participants. Laws and regulations can also be interpreted several ways, some not resonating with the spirit of the law.

Here Ethics and the Code of Professional Conduct becomes important.

It’s intimidating for an investor to navigate a global market with inconsistent rules and regulations. Investment managers who offer to voluntarily adopt a higher standard of professional conduct is likely to gain preference amongst the investment community. I think this is also why CFA Institute advocates adhering to the more stringent of the two – the local regulation and the guidelines on Ethics as prescribed by the Institute.

Lessons from the Panama Papers

The leak and subsequent publication of the Panama Papers has started to stir a hornet’s nest. This incident probably provides the perfect argument to illustrate why ethics is important.

At the centre of the storm is a Panamanian law firm named Mossack Fonseca. While what it did may not necessarily have been illegal, it certainly could have been more transparent about the way it operates. This opacity of operation created a perception that the firm was willing to exploit loopholes in the local regulations to further its own interest. And in an industry where perception is so important, this speaks volumes.

The aftermath of this revelation has caused significant ripples across the investment community. With ethics becoming increasingly important, more and more reputable firms will likely take a step beyond just adhering to the law and adopt best practices in ethical conduct and disclosure.

And this is also what sets them apart in the long run.

Thoughts? Let us know in the comments below. 

Zee Tan
Author: Zee Tan

 

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